This Is 'The Big One' for Brazilian Banking (int'l edition)
Banespa's sale will define the future of the industry

The workers standing in front of the headquarters of Banco do Estado de Sao Paulo were adamant. ''We're on strike until the sale is called off,'' says Eduardo Rondino, president of the employees' union.

But regardless of whether the protesters budge, the privatization of Brazil's largest state-owned bank, in a sale either to a local or foreign bank, is likely to go ahead on Nov. 20 after two years of delays caused by a slew of legal challenges. The minimum bid for Banespa, as the Sao Paulo bank is known, is $3 billion.

SIZE MATTERS. But the hefty price is not the only reason the Brazilian government has fought through the blizzard of strikes and lawsuits. The sale is seen as a defining event for the future of Brazil's banking industry. For one thing, it will determine whether foreign banks will finally take a place in the front ranks, or continue playing second fiddle to powerful local rivals. ''To compete in Brazilian retail banking you need scale. And this is the big one,'' says banking analyst Jason Mollin of Bear, Stearns & Co. in New York.

Indeed, size matters as it never has before. In the years of hyperinflation and high interest rates, Brazilian banks of any scale could sit on a pile of high-yielding government securities and get rich without lending a dime. But that was before the inflation-busting Real Plan was launched in 1994. Since then, inflation has dropped to less than 7% a year. And interest rates, while remaining comparatively high (the base rate is 16.5% a year), are also falling quickly. That has forced Brazil's banks to get back to basics--that is, making loans. It has also led to a new division of labor: small banks for high-earning niche sectors; big banks for the mass market.

Banespa is nothing if not big. It has assets of $14.9 billion and 576 branches, mostly in Sao Paulo, Brazil's wealthiest and most populous state. Whoever buys it will gain a formidable edge. ''Anyone who can add Banespa to their existing structure will take a gigantic leap forward,'' says Elio Duarte, director of institutional relations at the Brazilian subsidiary of Britain's HSBC Holdings PLC, one of the nine banks qualified to take part in the auction.

That means bidders will pay a premium not just to get their hands on Banespa but also to stop rivals from doing so. Four of the contenders are local: Bradesco, Itau, and Unibanco--the three biggest private-sector banks in Brazil, in that order--and Safra, an enterprising, but small, commercial bank. Besides HSBC, the foreign contingent includes Citigroup and FleetBoston of the U.S. and Spain's Banco Santander Central Hispano (BSCH) and Banco Bilbao Vizcaya Argentaria (BBVA).

Who will win the big prize? ''They all have the cash, that won't be a problem,'' says Tomas Awad, an analyst at Chase Manhattan in Sao Paulo. Yet Awad believes that only Bradesco or Itau would be able to efficiently integrate Banespa with their existing operations, cutting its costs while boosting its earnings. Banespa posted a profit of $385 million in the first nine months of the year, a figure considered respectable for a bank of its size.

For foreign banks, the stakes are even bigger. Citibank and FleetBoston have been in Brazil for decades, but they cater primarily to the rich--a narrow but lucrative segment. Banespa would be their ticket into the mass market. The Europeans already have a foothold in retail banking, thanks to acquisitions made over the past five years. Yet they lack scale. For them, the Banespa sale may be the last chance to pick up a large chunk of market share. Other state banks are due to hit the auction block, but none with Banespa's heft.

Regardless of the outcome, the privatization of Banespa will remap the banking landscape of Brazil. The remaining handful of midsize local banks will become increasingly attractive as takeover targets. After that, the big players will start looking at each other as either predators or partners. ''The scenario from here on is consolidation,'' Awad says.

That's bad news for Banespa's 23,000 employees. Whoever takes over the bank is going to pare back its bloated workforce. If it's one of the big Brazilian banks, a lot of branches, plus Banespa's entire back-office operation, may be closed down. The bank's striking workers are demanding a guarantee of no layoffs for a year. But Banespa's new owner is bound to drive a much harder bargain.

By Jonathan Wheatley in Sao Paulo

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This Is ``The Big One'' for Brazilian Banking (int'l edition)

CHART: How Banespa's Bidders Stack Up

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